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How to Prevent Foreclosure, Ohio Style   How Principles-Based Regulation is L...
Apr 21 2008 12:49PM EDT

Why Stockbrokers Need Close Scrutiny

Floyd Norris received an email today from a financial adviser who's upset at the level of supervision in his industry. No, he doesn't think there's too little, he thinks there's too much:

"As a financial adviser at a major Wall Street firm, I am amazed at the amount of resources spent to supervise our business practices. These firms spend crazy amounts of money policing our practices for things like mutual fund "B" share sales while a small amount of bankers and traders lost hundreds of billions of dollars on scam structured investments."

Norris is sympathetic; I'm not. This kind of regulatory supervision does not exist to stop the bank making stupid decisions or to minimize losses to shareholders. Rather, it exists because financial advisers have a fiduciary duty to their clients. If you want to recklessly lose your own money, go right ahead. But don't do that with your client's money.

Stockbrokers occupy a peculiar niche between the buy side and the sell side. Their clients are investors, not issuers, but neither are stockbrokers buy-side fund managers. As such, they deserve extra scrutiny: stockbrokers' profits generally come out of their clients' pockets, even as the brokers have a legal responsibility not to fleece their clients. Because the brokers' incentives aren't really aligned with those of their clients, it makes sense to keep a very close eye on their behavior.

So far, retail investors have managed to navigate the credit crisis about as well as could be hoped. The ones invested in auction-rate securities aren't happy, but the ones invested in a well-diversified set of stocks are doing much better than many much smarter investors. Insofar as scandalous activity has happened at banks, it happened far from the retail-facing arms. And I suspect that we have, at least in part, regulatory scrutiny to thank for that. So let's not start saying that there's too much of it.

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